This section presents management's discussion and analysis of our financial condition and results of operations. You should read the discussion in conjunction with our financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those described in these forward-looking statements as a result of various factors. This discussion is intended to assist in understanding our financial condition and results of operations.

Executive Summary

ECB Bancorp, Inc. is a bank holding company headquartered in Engelhard, North Carolina. Our wholly-owned subsidiary, The East Carolina Bank (the "Bank"), is a state-chartered community bank that was founded in 1919. For the purpose of this discussion, "we," "us" and "our" refers to the Bank and the bank holding company as a single, consolidated entity unless the context otherwise indicates.

Our consolidated assets increased 30.8% to $841.9 million on December 31, 2008, from $643.9 million at year-end 2007. Our loan portfolio increased 18.6% to $538.8 million at December 31, 2008, from loans of $454.2 million at year-end 2007 while deposits increased 19.5% to $629.2 million at year-end 2008 from $526.4 million at year-end 2007. Total shareholders' equity was approximately $67.9 million at year-end 2008.

In 2008, our net income was $3.4 million or $1.19 basic and $1.18 diluted earnings per share, compared to net income of $4.8 million or $1.65 basic and $1.65 diluted earnings per share for the year ended December 31, 2007. The 2008 net income represents a decrease of $1.4 million over reported 2007 net income mainly due to an increase in provision for loan loss expense.

Critical Accounting Policies

Our significant accounting policies are set forth in Note 1 to our audited consolidated financial statements included in Item 8 of this report. Of these significant accounting policies, we consider our policy regarding the allowance for loan losses to be our most critical accounting policy, because it requires management's most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and, therefore, the provision for loan losses and results of operations. We have developed policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, the results of regulatory examinations, and the discovery of information with respect to borrowers that is not currently known to management. For additional discussion concerning our allowance for loan losses and related matters, see "-Allowance for Loan Losses" and "-Nonperforming Assets and Past Due Loans."

We also consider our determination of retirement plans and other postretirement benefit plans to be a critical accounting estimate as it requires the use of estimates and judgments related to the amount and timing of expected future cash out-flows for benefit payments and cash in-flows for maturities and return on plan assets. Our retirement plans and other postretirement benefit plans are actuarially determined based on assumptions on the discount rate, estimated future return on plan assets and the health care cost trend rate. Changes in estimates and assumptions related to mortality rates and future health care costs could have a material impact to our financial condition or results of operations. The discount rate is used to determine the present value of future benefit obligations and the net periodic benefit cost. The discount rate used to value the future benefit obligation as of each year-end is the rate used to determine the periodic benefit cost in the following year. For additional discussion concerning our retirement plans and other postretirement benefits refer to Note 8 of our consolidated financial statements.

Results of Operations for the Years Ended December 31, 2008, 2007 and 2006

In 2008, our net income was $3.4 million or $1.19 basic and $1.18 diluted earnings per share, compared to net income of $4.8 million or $1.65 basic and $1.65 diluted earnings per share for the year ended December 31, 2007. The decrease in earnings is primarily due to an increase in provision for loan loss expense.

                                                      Year Ended
                                                     December 31,
                                               -------------------------
                                               2008      2007      2006
                                               -----     -----     -----
              Return on assets                  0.47 %    0.77 %    0.96 %
              Return on equity                  5.14      7.48     10.13
              Dividend payout                  61.34     42.42     32.85
              Shareholders' equity to assets    9.13     10.34      9.47

Our performance in 2008 reflects the continued execution of our core strategies:
(1) grow the loan portfolio while maintaining high asset quality; (2) grow core deposits; (3) increase non-interest income; (4) control expenses; and (5) make strategic investments in new and existing communities that will result in increased shareholder value. We continued to make strategic investments in our future as we completed construction on one branch that opened in 2008.

Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. The level of net interest income is determined primarily by the average balances (volume) of interest-earning assets and our interest-bearing liabilities and the various rate spreads between our interest-earning assets and interest-bearing liabilities. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest-earning asset portfolio, and the availability of particular sources of funds, such as non-interest-bearing deposits.

The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. The net interest rate spread does not consider the impact of non-interest-bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing non-interest-bearing deposits in earning assets.

Our net interest income for the year ended December 31, 2008 was $20.5 million, flat when compared to net interest income of $20.5 million for the year ended December 31, 2007. Our net interest margin, on a tax-equivalent basis, for 2008 was 3.16% compared to 3.75% for 2007. The decrease in our net interest margin is the result of decreased yields on our loan portfolio and increased competitive pricing for money market accounts and certificates of deposits. Our net interest rate spread, on a tax-equivalent basis, for 2008 was 2.63% compared to 2.95% for 2007. As a result of interest rate cuts by the Federal Reserve loan rates decreased more than rates paid on our interest-bearing liabilities. The spread decreased by thirty-two basis points as the change in the rates paid on interest-bearing liabilities was thirty-two basis points less than the change in yields earned on interest-earning assets for the year.

Total interest income decreased $644 thousand or 1.6% to $39.3 million in 2008 compared to $40.0 million in interest income in 2007. Increases in our average earning assets of $106.5 million in 2008 when compared to 2007 resulted in $6.8 million increase in interest income from 2007 to 2008 but this was offset by a decrease in interest income of $7.4 million from a decline in yields. We funded the increases in interest-earning assets primarily with certificates of deposit and Federal Home Loan Bank advances. The tax equivalent yield on average earning assets decreased 1.24 basis points during 2008.

The effect of variances in volume and rate on interest income and interest expense is illustrated in the table titled "Change in Interest Income and Expense on Tax Equivalent Basis." We attribute the decrease in the yield on our earning assets to the drop in short-term market interest rates. During 2008, the Federal Open Market Committee ("FOMC")

Similarly, our average cost of funds for 2008 was 3.33%, a decrease of 92 basis points when compared to 4.25% for 2007. The average cost on Bank certificates of deposit decreased 93 basis points from 5.02% paid in 2007 to 4.09% paid in 2008, while our average cost of borrowed funds decreased 245 basis points during 2008 compared to 2007. Part of the borrowing cost decrease was because on June 26, 2007, we redeemed all of our higher cost trust preferred securities ($10.3 million), originally issued June 26, 2002 which bore an interest rate of 3.45% over the three month LIBOR rate, with lower cost funding sources.

Total interest expense decreased $610 thousand or 3.1% to $18.8 million in 2008 from $19.4 million in 2007, primarily the result of decreased market rates paid on Bank certificates of deposit. The volume of average interest-bearing liabilities increased approximately $107.1 million when comparing 2008 with that of 2007. The decrease to interest expense resulting from decreased rates on all interest-bearing liabilities was $4.3 million and the increase attributable to higher volumes of interest-bearing liabilities was $3.7 million.

Throughout 2009, we believe our net interest margin will improve due to liabilities repricing at lower rates while our earning assets remain relatively flat. However, this expectation may not be realized and our net interest margin could decline if competitive pressures or other factors cause us to increase our deposit rates.

Our net interest income for the year ended December 31, 2007 was $20.5 million, a decrease of $.2 million or 1.0% when compared to net interest income of $20.7 million for the year ended December 31, 2006. Our net interest margin, on a tax-equivalent basis, for 2007 was 3.75% compared to 4.04% for 2006. The decreased net interest margin resulted from increased competitive pricing for money market accounts and certificates of deposits. Our net interest rate spread, on a tax-equivalent basis, for 2007 was 2.95% compared to 3.36% for 2006. As a result of competitive pricing pressure the rates paid on our interest-bearing liabilities increased more than the rates paid on our interest-earning assets. The spread decreased by forty-one basis points as the change in the rates paid on interest-bearing liabilities was forty-one basis points greater than the change in yields earned on interest-earning assets for the period.

Total interest income increased $3.4 million or 9.3% to $40.0 million in 2007 compared to $36.6 million in interest income in 2006. Increases in our average earning assets of $38.6 million in 2007 when compared to 2006 resulted in $2.5 million of the increase in interest income from 2006 to 2007. We funded the increases in interest-earning assets primarily with in-market certificates of deposit. Supplementing the additional earnings from increased volumes of earning assets was the increase in yield on earning assets. The tax equivalent yield on average earning assets increased 13 basis points during 2007 and resulted in $.9 million of the increase in interest income.

Similarly, our average cost of funds for 2007 was 4.25%, an increase of 54 basis points when compared to 3.71% for 2006. The average cost on Bank certificates of deposit increased 60 basis points from 4.42% paid in 2006 to 5.02% paid in 2007, while our average cost of borrowed funds decreased 20 basis points during 2007 compared to 2006. Total interest expense increased $3.5 million or 22.0% to $19.4 million in 2007 from $15.9 million in 2006; primarily the result of increased market rates paid on Bank certificates of deposit. The volume of average interest-bearing liabilities increased approximately $29.2 million when comparing 2007 with that of 2006. The increase to interest expense resulting from increased rates on all interest-bearing liabilities was $1.9 million and the increase attributable to higher volumes of interest-bearing liabilities was $1.6 million.

         Average Consolidated Balances and Net Interest Income Analysis



                                                                          Year Ended December 31,
                                    ---------------------------------------------------------------------------------------------------
                                                 2008                              2007                              2006
                                    -------------------------------   -------------------------------   -------------------------------
                                     Average    Yield/     Income/     Average    Yield/     Income/     Average    Yield/     Income/
                                     Balance     Rate      Expense     Balance     Rate      Expense    Balances     Rate      Expense
                                    ---------   ------     --------   ---------   ------     --------   ---------   ------     --------
                                                                          (Dollars in thousands)
Assets:
Loans-net(1)                        $ 499,771     6.27 %   $ 31,345   $ 426,965     7.89 %   $ 33,688   $ 404,676     7.73 %   $ 31,277
Taxable securities                    125,985     5.11        6,432      95,325     4.74        4,521      82,929     4.49        3,724
Nontaxable securities(2)               34,733     5.69        1,977      33,101     5.61        1,856      29,548     5.58        1,648
Other investments(3)                   10,279     2.50          257       8,859     6.20          549       8,479     5.86          497
                                    - -------   ------ -   - ------   - -------   ------ -   - ------   - -------   ------ -   - ------
Total interest-earning assets         670,768     5.96       40,011     564,250     7.20       40,614     525,632     7.07       37,146
Cash and due from banks                12,663                            14,877                            17,514
Bank premises and equipment, net       25,255                            24,391                            20,606
Other assets                           19,407                            18,396                            17,831
                                    - -------                         - -------                         - -------
Total assets                        $ 728,093                         $ 621,914                         $ 581,583
                                    - -------                         - -------                         - -------

Liabilities and Shareholders'
Equity:
Interest-bearing deposits           $ 488,309     3.33 %   $ 16,276   $ 417,675     4.10 %   $ 17,129   $ 386,209     3.46 %   $ 13,370
Short-term borrowings(4)               55,131     3.44        1,895      39,818     5.79        2,306      15,826     4.83          765
Long-term obligations                  21,120     3.10 %        654          -        -            -       26,223     6.69        1,754
                                    - -------   ------ -   - ------   - -------   ------ -   - ------   - -------   ------ -   - ------
Total interest-bearing
liabilities                           564,560     3.33       18,825     457,493     4.25       19,435     428,258     3.71       15,889
Non-interest-bearing deposits          90,031                            94,397                            92,988
Other liabilities                       7,037                             5,712                             5,234
Shareholders' equity                   66,465                            64,312                            55,103
                                    - -------                         - -------                         - -------
Total liabilities and
shareholders' equity                $ 728,093                         $ 621,914                         $ 581,583
                                    - -------                         - -------                         - -------
Net interest income and net
interest margin (FTE)(5)                          3.16 %   $ 21,186                 3.75 %   $ 21,179                 4.04 %   $ 21,257
                                                ------ -   - ------               ------ -   - ------               ------ -   - ------
Net interest rate spread (FTE)(6)                 2.63 %                            2.95 %                            3.36 %
                                                ------ -                          ------ -                          ------ -

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $672 thousand, $631 thousand, and $560 thousand for the years 2008, 2007, and 2006, respectively.

(3) Other investments include federal funds sold and interest-bearing deposits with banks and other institutions.

(4) For 2008, expense includes $ 350 thousand for interest on taxes.

(5) Net interest margin is computed by dividing net interest income by total average earning assets, net of the allowance for loan losses.

(6) Net interest rate spread equals the earning asset yield minus the interest-bearing liability rate.

         Change in Interest Income and Expense on Tax Equivalent Basis



                                             2008 Compared to 2007                    2007 Compared to 2006
                                      -----------------------------------     -------------------------------------
                                       Volume(1)    Rate(1)        Net         Volume(1)      Rate(1)        Net
                                      -----------   --------     --------     -----------     --------     --------
                                                                 (Dollars in thousands)
Loans                                 $     5,155   $ (7,498 )   $ (2,343 )   $     1,741     $    670     $  2,411
Taxable securities                          1,510        401        1,911             572          225          797
Nontaxable securities(2)                       92         29          121             199            9          208
Other investments                              62       (354 )       (292 )            23           29           52
                                      -- --------   - ------ -   - ------ -   -- -------- -   - ------ -   - ------ -
Interest income                             6,819     (7,422 )       (603 )         2,535          933        3,468
                                      -- --------   - ------ -   - ------ -   -- -------- -   - ------ -   - ------ -
Interest-bearing deposits                   2,626     (3,479 )       (853 )         1,190        2,569        3,759
Short-term borrowings                         707     (1,118 )       (411 )         1,275          266        1,541
Long-term obligations                         327        327          654            (877 )       (877 )     (1,754 )
                                      -- --------   - ------ -   - ------ -   -- -------- -   - ------ -   - ------ -
Interest expense                            3,660     (4,270 )       (610 )         1,588        1,958        3,546
                                      -- --------   - ------ -   - ------ -   -- -------- -   - ------ -   - ------ -
Net interest income                   $     3,159   $ (3,152 )   $     (7 )   $       947     $ (1,025 )   $    (78 )
                                      -- --------   - ------ -   - ------ -   -- -------- -   - ------ -   - ------ -

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $672 thousand, $631 thousand, and $560 thousand for the years 2008, 2007, and 2006, respectively.

Rate Sensitivity Management

Rate sensitivity management, an important aspect of achieving satisfactory levels of net interest income, is the management of the composition and maturities of rate-sensitive assets and liabilities. The following table sets forth our interest sensitivity analysis at December 31, 2008 and describes, at various cumulative maturity intervals, the gap-ratios (ratios of rate-sensitive assets to rate-sensitive liabilities) for assets and liabilities that we consider to be rate sensitive. The interest-sensitivity position has meaning only as of the date for which it was prepared. Variable rate loans are considered to be highly sensitive to rate changes and are assumed to reprice within 12 months.

The difference between interest-sensitive asset and interest-sensitive liability repricing within time periods is referred to as the interest-rate-sensitivity gap. Gaps are identified as either positive (interest-sensitive assets in excess of interest-sensitive liabilities) or negative (interest-sensitive liabilities in excess of interest-sensitive assets).

As of December 31, 2008, we had a negative one-year cumulative gap of 29.8%. We have interest-earning assets of $325.8 million maturing or repricing within one year and interest-bearing liabilities of $559.5 million repricing or maturing within one year. This is primarily the result of short-term interest sensitive liabilities being used to fund longer term interest-earning assets, such as loans and investment securities. A negative gap position implies that interest-bearing liabilities (deposits and other borrowings) will reprice at a faster rate than interest-earning assets (loans and investments). In a falling rate environment, a negative gap position will generally have a positive effect on earnings, while in a rising rate environment this will generally have a negative effect on earnings.

On December 31, 2008, our savings and core time deposits of $314.8 million included savings, NOW and Money Market accounts of $115.9 million. In our rate sensitivity analysis, these deposits are considered as repricing in the earliest period (3 months or less) because the rate we pay on these interest-bearing deposits can be changed weekly. However, our historical experience has shown that changes in market interest rates have little, if any, effect on those deposits within a given time period and, for that reason, those liabilities could be considered non-rate sensitive. If those deposits were excluded from rate sensitive liabilities, our rate sensitive assets and liabilities would be more closely matched at the end of the one-year period.

               Rate Sensitivity Analysis as of December 31, 2008



                                                                       Total
                                    3 Months           4-12          Within 12         Over 12
                                     Or Less          Months           Months          Months          Total
                                    ---------       ----------       ----------       ---------      ---------
                                                              (Dollars in thousands)
Earning assets:
Loans-gross                         $ 283,563       $   35,155       $  318,718       $ 220,118      $ 538,836
Investment securities                   1,899              428            2,327         237,382        239,709
Interest bearing deposits                 902               -               902              -             902
FHLB stock                              3,859               -             3,859              -           3,859
                                    - ------- --    - -------- --    - -------- --    - ------- -    - ------- -
Total earning assets                  290,223           35,583          325,806         457,500        783,306
                                    - ------- --    - -------- --    - -------- --    - ------- -    - ------- -
Percent of total earnings assets         37.1 %            4.5 %           41.6 %          58.4 %        100.0 %
Cumulative percentage of total
earning assets                           37.1             41.6             41.6           100.0

Interest-bearing liabilities:
Savings, NOW and Money Market
deposits                              115,893               -           115,893              -         115,893
Time deposits of $100,000 or
more                                   80,043          129,485          209,528          14,657        224,185
Other time deposits                    67,017          109,344          176,361          22,516        198,877
Short-term borrowings                  57,716                            57,716              -          57,716
. . .